Compensation

The Importance of Compensation

• Impacts an employer’s ability to attract and retain employees.

• Ensure optimal levels of employee performance in meeting the organization’s strategic objectives.

• Compensation’s components– Direct compensation in the form of wages or salary

• Base pay (hourly, weekly, and monthly)

• Incentives (sales bonuses and or commissions)

– Indirect compensation in the form of benefits• Legally required benefits (e.g., Social Security)

• Optional (e.g., group health benefits)

Theory Behind Compensation

• Equity Theory– Comparing inputs and outputs of a similar co-worker– Perceived inequity affects employee effort

• Expectancy Theory– People are motivated by intrinsic and extrinsic outcomes they

desire.– People will only be motivated if outcome is possible.– People will only be motivated if outcome is contingent.

Equity Theory

• Internal equity– Comparison of my input / reward ratio with that of similar

others.– Employees may seek to address imbalance by changing

their inputs.– Fairness of pay differentials between different jobs in the

organization can be established by job ranking, job classification, point systems and factor comparisons.

• External equity– Fairness of organizational compensation levels relative to

similar jobs in other organizations.

“Monkeys Demand Equal Pay”

A recent study shows brown capuchin monkeys refused to play along when they saw another monkey get a better payoff for performing the same work.

The monkeys were trained to trade a granite token for a piece of cumber. When the reward was the same for both monkeys, they took the cucumber 95 percent of the time.

But it was a different story when one monkey was given something better -- namely, a grape. Then, the other monkey often pitched a fit -- either throwing the token, refusing to eat the cucumber or giving it to the other monkey.

Associated Press 2003

Equity Theory

Fairness about pay differentials among individuals who hold the same job can be established by using:

• Seniority-based pay systems that reward longevity.• Merit-based pay systems that reward employee

performance.• Incentive plans that allow employees to receive part of

their compensation based on their job performance.• Skills-based pay systems.• Team-based pay plans that encourage cooperation and

flexibility in employees.

Types of Base Pay Systems

• Job-based– Pay the job (not the person)– Market-based (external equity focus)– Point factor-based (internal equity focus)

• Skills / knowledge-based– Pay the person (not the job)– 62% of F1000 firms used some type of skill based

pay in 1999

Job Based Pay

Attraction Depends on market pricing

Motivation No performance impact

Skill Development Learn job-related and upward mobility skills

Culture Bureaucratic, hierarchical

Structure Hierarchical, individual jobs and differentiation

Cost Good control of individual pay

Individual Skill/Knowledge Based Pay

Attraction Attracts learning-oriented individuals, high skills individuals

Motivation Little performance impact

Skill Development Motivates needed skill development

Culture Learning, self-managing

Structure Flat or team-based

Cost Higher individual pay

When to Use a Job-based Pay Policy

• A job-based pay work best in situations where:– Job duties are stable.– Skills are generic.– Employees move up through the ranks over time.– Jobs are fairly standardized within the industry.

• Drawbacks of a job-based pay system– Discounts individual ability.– Discourages lateral movement.– Tends to be bureaucratic, mechanistic, and inflexible.– Employees’ perceptions of equity are more important than market

or point data.

Individual-based Compensation

• Individual-based compensation works when:– The firm has a relatively educated workforce.– Employees often do different jobs– Technology changes frequently.– Employee participation and teamwork are encouraged.– Opportunities for upward mobility are limited.– Opportunities to learn new skills are present.– The costs of employee turnover and absenteeism in terms of lost

production are high.

Pricing Jobs

• First conduct job analysis – Qualifications– KSA’s

• Non-quantitative methods– Job Ranking (create hierarchy of jobs)– Job Classification (create groups of similar jobs)

• Quantitative Methods– Point factor systems– Compare “compensable factors”

• Market pricing

Compensable Factors

Hay Factors– Know-how– Problem solving– Accountability

National Position Evaluation Plan (MAA)– Skill– Effort– Responsibility– Job Conditions

Characteristics in the job that the organizational values and that help achieve its objectives.

Pricing Jobs

Variable Pay Incentives

• Linking performance to pay– Individual – Bonuses, piece-rates, stock options– Team – Bonuses and awards– Plant / Unit / Business – Gainsharing, profit sharing– Corporation – ESOP’s

• “Line of sight” is the perceived link between individual behavior and the reward.

Individual Merit

Attraction Good for high performers

Motivation Good line of sight

Skill Development Learn skills that lead to rewarded performance

Culture Performance oriented, job focused

Structure Individual and independent jobs

Cost Depends on the size of the awards

Team Incentives

Attraction Good if team performs well

Motivation Moderate line of sight

Skill Development Encourages team skills

Culture Team focused

Structure Team-based and integrated

Cost High if significant awards given

Organizational Plans

Attraction Good if organization performs well

Motivation Weak line of sight

Skill Development Encourages broad understanding of business

Culture Business involvement

Structure Organization wide integration

Cost Possible self-funding if based on performance improvement

Pay for Performance Requires

1. Definition of performance– How are we going to measure and compare people?

2. Distribution of performance– Can we distinguish high and low performers?

3. Decide the increase for each level of performance.– How large a difference between high and low

performers?

Key Strategic Issues in Compensation

• Determining compensation relative to the market.• Striking a balance between fixed and variable

compensation.• Deciding whether or not to utilize team-based versus

individual pay.• Creating the appropriate mix of financial and non-

financial compensation.• Developing a cost-effective compensation program

that results in high performance.

New Thinking for the New Millennium

• Strategic approaches to may compensation (pay) systems more responsive:– Pay the person for individual worth (knowledge, skills and

competencies) rather than for the value of a job they perform.

– Reward excellence through a pay for performance compensation that establishes a clear relationship between a significant amount of pay and attainment of organizational objectives.

– Individualize the pay system to give employees choices in how they are rewarded and what reward they receive.